Turnaround Initiatives and Auditors' Going-Concern Judgment: Memory for Audit Evidence

2013 ◽  
Vol 32 (3) ◽  
pp. 105-121 ◽  
Author(s):  
Liesbeth Bruynseels ◽  
W. Robert Knechel ◽  
Marleen Willekens
Keyword(s):  
Direct Effect ◽  
Mediation Analysis ◽  
Data Availability ◽  
Direct Link ◽  
Going Concern ◽  
Cost Cutting ◽  
Strategic Initiatives ◽  
Audit Evidence ◽  
Going Concern Opinion ◽  
Distressed Firms

SUMMARY: This study uses an experiment to investigate how management turnaround initiatives influence auditors' going-concern decisions for financially distressed firms. Using mediation analysis, we are able to distinguish between a direct effect of strategic and operating turnaround initiatives on going-concern judgment and a mediated effect through auditors' evaluation of subsequent financial evidence. Results from the experiment indicate that operating turnaround initiatives (e.g., cost cutting) are associated with lower relative recall of positive financial evidence and a higher likelihood of receiving a going-concern opinion. Further, we find no evidence of a direct link between client operating or strategic initiatives and an auditor's going-concern judgment. Data Availability: Data are available from the authors upon request.

The Auditor's Going-Concern Opinion as a Communication of Risk

2011 ◽  
Vol 30 (2) ◽  
pp. 77-102 ◽  
Author(s):  
Allen D. Blay ◽  
Marshall A. Geiger ◽  
David S. North
Keyword(s):  
Financial Distress ◽  
Balance Sheet ◽  
Control Sample ◽  
Data Availability ◽  
Market Valuation ◽  
Audit Opinion ◽  
Going Concern ◽  
Income Statement ◽  
Going Concern Opinion ◽  
Distressed Firms

SUMMARY In this study, we examine the proposition that the auditor's going-concern modified opinion is a valuable risk communication to the equity market that results in a shift of the market's perception of financially distressed firms. Specifically, our analyses reveal that the market valuation is significantly altered from a focus on both the income statement and balance sheet to a balance sheet-only focus in the year a company receives a first-time going-concern modified opinion. These results hold even after controlling for several common measures of financial distress and when examining a larger control sample of distressed firms. We also document that the market devalues a company's inventory and places increased weight on cash, receivables, and long-term assets and liabilities as a result of the auditor's modification. This indicates that the going-concern modification provides incremental information specifically related to abandonment or adaptation risk. Our results provide evidence that the market interprets the going-concern modified audit opinion as an important communication of risk that results in a substantial shift in the structure of the market valuation for distressed firms. Data Availability: All data are available from public sources. JEL Classifications: M41.

The effect of real activities manipulation on going concern audit opinions for financially distressed companies

2018 ◽  
Vol 17 (4) ◽  
pp. 514-539
Author(s):  
Hongkang Xu ◽  
Mai Dao ◽  
Jia Wu
Keyword(s):  
Audit Quality ◽  
Positive Association ◽  
Content Type ◽  
Going Concern ◽  
Accruals Management ◽  
Reporting Decisions ◽  
Going Concern Opinion ◽  
Distressed Firms ◽  
Real Activities Manipulation ◽  
Auditor Reporting

Purpose This study aims to examine the effect of real activities manipulation (RAM) on auditors’ decision of issuing going concern (GC) opinions for distressed companies. Design/methodology/approach This study estimates and examines three types of RAM: reduction of discretionary expenses, sales manipulation and overproduction. It investigates the effect of RAM on auditor reporting conservatism by including the three measures of RAM methods in logistic regressions that explain the issuance of going concern opinions. The authors perform the analysis specifically on distressed firms for 2004-2013 period. Findings This study finds a significant and positive association between RAM and the likelihood of receiving going concern opinion in the financial distressed firm sample, suggesting that client’s abnormal business activity affects the auditor reporting conservatism. Practical implications This study provides evidence that auditors make going concern reporting decisions in consideration of the client’s abnormal operating decisions and management’s opportunism. Originality/value Recent literature argues that auditors have little recourse other than to resign if a client uses RAM to impact earnings or the financial statements, and hence the enhanced audit quality in the post-SOX period is due to the shift from using accruals management to RAM (Cohen et al., 2008; Chi et al., 2011; Kim and Park, 2014). The evidence provided in this study indicates that auditors report more conservatively (rather than simply resign) in response to the aggressive RAM.

Going Concern Opinion and Cost of Equity

2014 ◽  
Vol 33 (4) ◽  
pp. 1-39 ◽  
Author(s):  
Keval Amin ◽  
Jagan Krishnan ◽  
Joon Sun Yang
Keyword(s):  
Positive Association ◽  
Equity Capital ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Significant Positive Association ◽  
Audit Opinion ◽  
Going Concern ◽  
Going Concern Opinion ◽  
Distressed Firms ◽  
The Cost

SUMMARY: Prior studies document a negative market reaction to going concern opinions. We extend this literature by focusing on the link between the going concern opinion and the cost of equity capital. Using two different samples (one comprising distressed firms and the other matched on propensity score), we document a significant positive association between the issuance of the going concern opinion and the firm's subsequent cost of equity capital. This result is robust to sensitivity tests using various subsamples, time periods, and multiple methods for computing the cost of equity capital. We also examine the association between changes in the audit opinion (going concern to clean opinion and vice versa) and subsequent changes in cost of equity. We find that the cost of equity increases between 3.3 percent and 5.7 percent for firms that receive a first-time going concern opinion. This evidence illuminates the relevance of going concern opinions and the value of the information embedded in them.

Information Transfer of Bankruptcy Announcements: Examining the Impact of Auditor Opinions

2019 ◽  
Vol 34 (1) ◽  
pp. 45-66
Author(s):  
Jeffrey R. Casterella ◽  
Rosemond Desir ◽  
Matthew A. Stallings ◽  
James S. Wainberg
Keyword(s):  
Capital Market ◽  
Stock Price ◽  
Information Transfer ◽  
Data Availability ◽  
Going Concern ◽  
Market Participants ◽  
Audit Firms ◽  
Peer Firms ◽  
Going Concern Opinion ◽  
The Impact

SYNOPSIS Auditing standards require auditors to consider whether there is “substantial doubt” that their client will remain a going concern and to, accordingly, modify the audit report (PCAOB AS 2415). Prior research reports larger negative excess returns for bankrupt firms when bankruptcies occur without a prior going concern opinion. We investigate whether such audit opinions can also have an impact on industry peer firms. We find that peer firms experience significantly larger negative stock price drops when rivals' bankruptcies are not preceded by a going concern opinion. In addition, we find evidence of incremental stock price declines for peer firms when Big N audit firms fail to issue a going concern opinion. These findings should be of significant interest to regulators, auditors, and capital market participants as they serve to enhance our current understanding of the importance of going concern opinions for the share pricing of industry peer firms. JEL Classifications: G14; G33; M4; M42. Data Availability: All data are from public sources identified in the manuscript.

Business Strategy and Auditor Reporting

2016 ◽  
Vol 36 (2) ◽  
pp. 63-86 ◽  
Author(s):  
Yu Chen ◽  
John Daniel Eshleman ◽  
Jared S. Soileau
Keyword(s):  
Business Strategy ◽  
Data Availability ◽  
Material Weakness ◽  
Going Concern ◽  
Going Concern Opinion ◽  
Auditor Reporting ◽  
The Cost ◽  
Type Ii Errors ◽  
To Receive ◽  
Organizational Literature

SUMMARY This study examines whether a firm's business strategy influences auditor reporting. We rely on the organizational literature to develop our prediction that firms utilizing the innovative “prospector” strategy will be more likely than firms utilizing the cost-leadership “defender” strategy to receive both going concern and material weakness opinions. Our empirical evidence supports this prediction. Specifically, we find that, among a sample of financially troubled firms, prospectors are significantly more likely than defenders to receive a going concern opinion. We then analyze a sample of clients who subsequently filed for bankruptcy and find that auditors are less likely to issue going concern opinions to prospector clients. This indicates that auditors commit more Type II errors when auditing prospector clients. We also find that prospectors are significantly more likely than defenders to receive a material weakness opinion. Taken together, the evidence suggests that business strategy is a significant determinant of both going concern and material weakness auditor reporting. JEL Classifications: M41; M42; L10. Data Availability: All data are available from public sources identified in the text.

scholarly journals Evidence On The Effect Of Financial Distress On Type II Audit Errors

2011 ◽  
Vol 27 (6) ◽  
pp. 135
Author(s):  
Paul Wertheim ◽  
Michael Robinson
Keyword(s):  
Financial Distress ◽  
Future Research ◽  
Type Ii ◽  
Main Research ◽  
Going Concern ◽  
Sarbanes Oxley ◽  
Going Concern Opinion ◽  
Distressed Firms ◽  
The Relationship ◽  
Audit Effectiveness

A Type II audit error is defined as the failure of an auditor to issue a going concern audit opinion for a client that subsequently declares bankruptcy. Prior research studies have examined audit effectiveness (as measured by Type II audit errors) following the Sarbanes-Oxley Act of 2002, and have generally found an increase in the auditors likelihood of issuing going-concern audit opinions. This increase in the auditors likelihood of issuing a going concern opinion post-Sarbanes-Oxley has been interpreted as an increase in the level of auditor conservatism. [For example, see Geiger et al. (2005) and Fargher and Jiang (2008)]. However, prior studies have often limited their analysis of going-concern audit effectiveness to firms that were already in financial distress, and have also failed to specifically address the extent to which varying levels of financial distress affects the auditors propensity to issue a going-concern opinion. This raises the main research questions addressed in this study: Does the relationship between financial distress and the probability of receiving a going-concern differ for distressed versus non-distressed firms, and more importantly, to what extent do varying levels of financial distress affect this relationship? We find that the relationship between financial distress and the probability of receiving a going-concern opinion is not linear, as is assumed in prior studies. Rather, we find that the positive relationship between financial distress and going-concern opinions applies only for certain levels of financial distress. These results have implications both in the interpretation of previous auditing research that has incorporated variables for financial distress, as well as implications for the design and interpretation of future research.

Auditor Differentiation, Mitigating Management Actions, and Audit-Reporting Accuracy for Distressed Firms

2011 ◽  
Vol 30 (1) ◽  
pp. 1-20 ◽  
Author(s):  
Liesbeth Bruynseels ◽  
W. Robert Knechel ◽  
Marleen Willekens
Keyword(s):  
Financial Distress ◽  
Manufacturing Industries ◽  
Short Term ◽  
Industry Specialization ◽  
Reporting Accuracy ◽  
Going Concern ◽  
Management Actions ◽  
Audit Firms ◽  
Going Concern Opinion ◽  
Distressed Firms

SUMMARY: In this paper we examine whether there is auditor differentiation through industry specialization and audit methodology in judging the adequacy of mitigating management actions as implemented by financially distressed companies. Using a sample of U.S. companies from manufacturing industries (SIC 20–39) that went bankrupt between 1999–2002, we find evidence that specialist auditors are more likely to issue a going-concern opinion for soon-to-be bankrupt companies when management undertakes strategic turnaround initiatives, relative to non-specialist auditors. Interestingly, and counter to our expectations, we find that audit firms that use a business risk audit methodology are less likely to issue a going-concern opinion for a firm that subsequently goes bankrupt if the client has undertaken operating initiatives to mitigate financial distress. Finally, we also find very strong evidence that all auditors, irrespective of type, are less likely to issue a going-concern opinion for clients that subsequently go bankrupt when the client has plans to raise cash in the short term.

scholarly journals Does the Market Know? Going Concern Opinion Release and Firm Fundamentals

2019 ◽  
Vol 9 (1) ◽  
pp. 135
Author(s):  
Jian Huang ◽  
Han Yu
Keyword(s):  
Cash Flows ◽  
Equity Market ◽  
Market Liquidity ◽  
Return On Assets ◽  
Audit Opinion ◽  
Going Concern ◽  
Short Sellers ◽  
Market Signals ◽  
Going Concern Opinion ◽  
Distressed Firms

Using a significant auditing event-the going concern audit opinion-we investigate the market’s forecasting ability and the importance of firm fundamentals in predicting the going concern event. First, we find that the equity market signals the upcoming going concern announcement as early as 30 days in advance. Specifically, during the window of [-30, -1] leading up to the announcement, the excess returns to going concern firms are 9.98% worse than the matched distressed firms. Moreover, short sellers, a group of sophisticated investors, significantly increase their shorting activities during days before the release of the going concern opinions. Furthermore, we find that firm fundamentals, which are observable to the market, are significantly predictive to the issuances of going concern. These variables include a firm’s operating performance (return on assets and operating cash flows), equity market liquidity, stock momentum, and filing delay. Overall, our evidence supports the perception that the market can forecast the going concern opinion release and points out its possible channel as well.

The Relationship between Audit Team Composition, Audit Fees, and Quality

2017 ◽  
Vol 36 (3) ◽  
pp. 115-135 ◽  
Author(s):  
Sarowar Hossain ◽  
Kenichi Yazawa ◽  
Gary S. Monroe
Keyword(s):  
Audit Quality ◽  
Positive Association ◽  
Audit Fees ◽  
Professional Staff ◽  
Data Availability ◽  
Team Composition ◽  
Going Concern ◽  
Going Concern Opinion ◽  
Audit Team ◽  
First Time

SUMMARY Using Japanese data, we investigate whether there is a positive association between audit team composition based on the number of senior auditors, assistant auditors, and other professional staff on the audit team and audit fees and a variety of commonly used measures of audit quality (likelihood of issuing a going concern opinion and a first-time going concern opinion for a sample of financially distressed companies, the absolute value of discretionary and working capital accruals). We find that the number of senior auditors, assistant auditors, and other professional staff on the audit team are positively associated with audit fees. We find that the number of senior auditors on the audit team has a positive association with audit quality. However, the number of assistant auditors and other professional staff on the audit team are not significantly associated with any of our audit quality measures. JEL Classifications: M41; M42. Data Availability: All data are publicly available from the sources indicated in the paper.

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